Or, the seemingly never-ending renovation…
Or, “Fun with the 203K loan.
Seeking to escape the frenzy, noise and HOA overlords of our South Riding, Virginia home (and ditch the upside-down, ghastly mortgage), Hubs and I bought what we hope will be our “forever home” on the side of a mountain in Warren County. It’s just outside the “Canoe Capital” Front Royal, Va. It’s a fabulous location and the view off the deck, clearly visible through the double set of patio doors in the den, is amazing. In the winter we can see the entire upper Shenandoah River valley. We are treated to spectacular sunsets every night.
When we started our property search we knew we’d be better off with a “fixer upper”, and would likely take out a guaranteed FHA renovation loan to finance the work. It’s been a long, long process, between getting the financing approved, getting contractors and putting up with dust, noise and intrusions during what seemed like a never-ending reconstruction process. Looking back I can definitely state that the results made it all worthwhile.
Not wanting to end up in another upside-down home (that’s a long story for another day), we decided to do some of the work ourselves. That was a good idea. Buying the cabinets, appliances and light fixtures on credit wasn’t such a good idea, but que sera sera.
Our first step was to strip out all the carpet from the entry floor (technically a basement, but it’s a raised ranch. The entry isn’t even at grade level.) We paid Lowe’s to install hand-scraped Acacia engineered hardwood flooring on the entire lower level except one little bathroom. That enabled us to move into the house with our two cats, who were certain to pee on the carpet. We hired a fantastic crew of polite, energetic and STRONG young men with two trucks from Shenandoah Valley Moving and Storage. Some of our stuff they offloaded at a climate controlled storage facility near the old house in Chantilly, VA. Some of it they offloaded at their own storage facility near Front Royal. The rest of it they crammed into a couple of rooms in the new house, out of the way of the early renovation stages.
Included in the 2 truckloads they delivered was the entire shipment of IKEA cabinets for the kitchen. We bought the cabinets in April during IKEA’s annual kitchen sale, saving enough in the process to pay for the bathroom cabinets which we purchased later. I’ll save the IKEA story for an entire future post.
Until we started looking for older homes, I’d never heard of this program. Hubs found out about it online, and we started trying to learn more. This seems to be one of the best-kept secrets in real estate. Ever wonder how all those clients for “Property Brothers”, “Fixer Upper” and the like get their money? It’s likely the FHA 203(k), but they never mention it. They should.
We couldn’t find a lot of information on the program, but the best source was the HUD website. Simply put, this program enables qualified buyers and homeowners to finance up to 110% of the appraised value of the home AFTER REHAB. There are two types of rehab loans, the streamlined and the full 203(k). The streamlined loan is for “minor” rehab and cosmetic upgrades, between $5000 and $35,000 in total cost. It’s a simpler process, and approval is often easier and quicker, hence the name. You can find a lot of information on this loan through a simple Google search. Here’s one decent source. You’ll note there are a lot of limitations. For instance, you can’t do structural repairs, and you can’t pay any subcontractor in more than 2 draws.
We knew our project would easily exceed the streamlined loan limit. The house we bought hadn’t been touched since it was built in 1988, except to repaint the interior and install new carpet (what a waste of money on both items, since we immediately tore out the carpet and all the walls got repainted.)
There are steps you need to follow if you use 203(k) financing, and try your best to A) do them in order, and B) be patient!
- Hire a design firm or architect to draw up plans. We skipped this step. I’m an engineer, had access to some decent home design software, and my father was a builder. I figured I could draw up the floor plan changes, make up a list of details, and that would suffice. It did, but I wish we’d paid the few grand to have professional plans drawn up. We’d have saved a lot of time and even money down the road.
For instance, when the contractor submitted my floorplans for permit approval, the plan reviewer had a lot of questions and markups, that revealed how little I knew about code requirements. We could have saved a month just by having a professional designer involved.
Even if you are making all your own design and aesthetic choices, get someone who knows current local codes work the drawings.
- Once you have your drawings, hire a 203(k) consultant. This person works on a flat fee basis, with fees established by HUD. The cost is around $1200 total, depending on how many draw inspections you pay for. The up-front fees are included in the mortgage. The consultant inspects your property up front for any damage or obvious code deficiencies to bring the home up to HUD requirements. For instance in our case, our consultant spotted a lot of exterior damage that we hadn’t. She also required some minor lot regrading that will likely save us some water damage in the future.
- The consultant will draft a Specification of Repairs (SOR). All of the work to be done is broken down by craft: electrical, plumbing, tile, drywall, painting, exterior are all detailed in separate sections. This facilitates your general contractor’s paying his subcontractors.
- Once you have your drawings and the SOR, THEN start getting general contractor bids for the work. HUD requires you to have a general contractor. It can be a family member if you’re lucky enough to have a relative in the business. In a few rare instances they will approve the homeowner as the general contractor but it’s not recommended. It wasn’t a consideration for us. Not only did we not have the expertise “in house” we didn’t know any of the local tradesman. You really want someone who already has working relationships with subcontractors and who can hire quality.
Try to get at least 3 bids. Good luck. This is where we ran into our first (and worst) problems. We had three factors working against finding a good contractor: availability, familiarity with the 203(k) process and the financial health to be able to work on spec.
The biggest drawback to the 203(k) program is designed to protect the homeowner. HUD structured the program such that the contractor isn’t paid until work is complete. No money upfront. If the contractor has to borrow to purchase expensive materials or fixtures, then he eats the cost of financing or lumps it into his overhead. This used to be the way all general contractors worked. In recent years, however (or maybe it’s just true in “hot” building markets) contractors have begun wanting at least half up front. This has led to a lot of heartache for homeowners left with shoddy or incomplete work if the contractor takes their money and disappears, or does part of it then goes belly up. So HUD requires payment AFTER completion, in up to 5 draws. That puts the burden on the contractor, who must be able to buy materials on account and have subs who will trust they’ll get paid.
We went through the entire yellow pages, all of HomeAdvisor, Angie’s List, recommendations from our neighbors and every web search we could dig up looking for someone to bid on our work. We ended up with two bids and selected the most reasonable. We liked the guy and his office manager. We got along great and they seemed to know their business. The contractor was related to our realtor (should have been a red flag right there, but we were getting desparate).
- Once you have a bid from your selected contractor, then provide him with the SOR and INSIST that he structure his bid to EXACTLY conform to the breakdown in the SOR. We were fortunate in that our consultant was patient enough to rework the bids, otherwise we might have paid a lot extra to have her take the contractor’s by-the-room bid and break it down by craft.
- When you have an SOR, with costs, overhead and contingency (usually 10-15% to cover unexpected items), then apply for financing. You’ll probably have only a couple of lenders who deal with these loans. We found 2–one in nearby Manassas, Virginia, and another in Washington, DC (close to my workplace). We ended up going with the local lender for convenience–and the fact that the loan officer was so much more available and responsive.
The loan application, appraisal and underwriting process is very similar to any purchase mortgage. The only real difference is that the appraisal submits two reports. One is the appraised value of the house as-is. The second is his estimate of value after the renovation is complete. This is another area where having a professional designer or architect involved can help. The better your appraiser can visualize the finished project, the more likely you are to get an appraisal that provides enough money to do the work.
We provided our appraiser with detailed drawings and specs for the kitchen cabinets, cost sheets and specs on all the appliances, and lots and lots of photographs of every design choice we’d made, right down to the cabinet pulls and light fixtures. We had samples of our tile and engineered flooring. We had specs for the upgraded Shaker style interior doors. We spent several hours with him, making sure that he knew how the house would look.
- With approved financing, you can start work. We did 95% of the demolition ourselves. The contractor supplied a dump trailer (no room on our extremely sloped lot for a dumpster) and we had a blast tearing out walls, ripping up floors and smashing out tile. The best part we saved for last; tipping the old commode over the deck rail into the dump trailer 20 feet below. <insert video>. The only part we couldn’t finish was removing the top of the stud walls from the ceiling. That was causing blown-in cellulose “dog barf” insulation to cascade into the house. We left the last bit for the professionals.
We worked around the plumbing and wiring, cutting wall studs to enable us to leave the wires hanging in place. The circuit breakers were pulled, but we wanted to leave the electricians the most flexibility.
- Keep your contractor. That’s when everything sort of fell apart. It had taken so long to get the financing approved that summer was in full swing and our contractor had taken on other work. So much so that he had no workmen available for our project. We started demolition in May. On August 1 we turned the project over to the contractor. By the first of November we still had no permits, and no guaranteed start date. We ended up having to fire that contractor, pay him for the dump loads and a trivial bit of other work, and start again.
It took 2 months and a half-dozen site visits before we finally had a new contractor. What was even more difficult that finding a 203(k)-savvy contractor was finding one who wasn’t afraid to work on our mountain in the winter. We’re only about half-way up the mountain and the roads are good in all but the worst conditions. Nevertheless, every contractor we interviewed either refused to work on spec or was afraid to get held up by snow and ice.
Work finally started in mid-February. That was one year after we closed on the purchase loan. We’d been living in a house with no central heat and camping out in a single bedroom downstairs, using a “camp kitchen” since June.
- With permits in hand and properly displayed onsite, your contractor can begin work. We worked very closely with our contractor to determine the order in which things were worked. We needed to get the kitchen completed first. We had to assemble and hang 27 IKEA cabinets, which required him to get the rough-in electrical, plumbing and drywall finished first. The floor had to go in before cabinets, and the wall painted. He hung the rails for us (trust a professional to get the cabinet rails installed level, true, flush and plumb. Your entire kitchen depends on it, since the cabinets hang from rails).
We allowed our contractor to place a realtor-type lockbox on the house to give the subs access if we weren’t home. I work out of the house three days per week. Having a couple of weekdays where I was onsite to answer questions really streamlined things, but I had to put up with a lot of noise (and be presentable at 7 am when strange men would start working in my house).
- As things progressed, we were finally able to start paying the contractor. The process is simple: the consultant inspects the work and determines the degree of completeness for each task in the SOR. For instance, the kitchen floor was tiled, so that was agreed–between us, the contractor and the consultant–to be 25% of the total tiled flooring. Every aspect, from stud walls to drywall was inspected and a factor applied against the total work to arrive at a value for the work completed.
(Incidentally, if you are familiar with the concept of Earned Value Management, you can compare the amount of work paid for against the amount of time spent to see if your project is on track. Our guy had completed 25% of the work but had passed the half-way point in our project schedule. We met with him to talk about what steps he would take to complete the project on time. )
- The bank will draft a check for 90% of the value of completed work. Both the homeowner and contractor have to endorse the check, which is sent FedEx to the homeowner. So you control the money flow–another way to keep your contractor honest.
I challenge you to complete any home construction or remodeling project without at least a few changes. HUD provides change forms for the homeowner or consultant to fill out. The contractor’s quote or invoices for the cost difference gets attached and it becomes part of the SOR. Among the types of changes you might see:
– Fixtures or finishes that end up costing more than estimated. We had change orders for bathroom fixture selections that were over the allowance the contractor specified, and for a slight over-run on the kitchen countertops.
– Unforseen issues, such as electrical systems that have to be updated to code and are discovered once the walls are opened.
– Scope changes. We decided halfway through construction (after we knew we were unlikely to see any more surprises) to replace the original-equipment vintage air conditioner with a heat pump. This allowed us to eliminate the planned baseboard heaters in every room–code required a thermostatically-controlled, hardwired heating system in every room. We also eliminated some items from the scope, resulting in a negative cost adjustment.
- When you and your contractor agree that everything is finished FINALLY (be sure to have a warranty in place for punchlist items and issues after completion) the consultant will perform a final inspection against the SOR and all change orders. Then the bank will issue a final draft to pay the remaining money owed the contractor. If there is any money leftover from the 10-15% contingency, that money is either:
– deposited into the loan account against the outstanding principle, or,
– refunded to the homeowner to defray the cost of out-of-pocket items or homeowner purchased material. In our case, the remainder was just enough to pay us back for the appliances we purchased from Sears (during an annual markdown, of course).
There will always be a few missed punchlist items, problems or things everyone missed during all those inspections. We found a dead electrical plug in the den that had been cut off when the electricians rewired the kitchen. We’d mentioned it during the project but it fell in a crack. The electricians did a great job running new power to that circuit without doing a lot of damage to the finished drywall. We also had some minor issues with plumbing in the utility space that took a few callbacks to resolve.
- I can’t stress strongly enough the importance of establishing, and maintaining, good relationships with your contractor, your 203(k) consultant, your loan account manager and your local suppliers. As in any other aspect of life, being able to talk about issues as they arise, and work out solutions together, makes the process so much less stressful.
If you have questions about the process, send me an email to email@example.com.